HSBC: How Simple Became Complicated, and Costly

HSBC takes its name from its roots as the Hongkong and Shanghai Banking Corporation, but there has long been a joke that the name stands for "How Simple Became Complicated."

LONDON -- HSBC takes its name from
its roots as the Hongkong and Shanghai Banking Corporation, but
there has long been a joke inside and outside the firm that the
name stands for "How Simple Became Complicated".

That complexity in part explains how the London-based bank
ended up with the biggest fine ever imposed on a financial firm
by U.S. regulators on Tuesday - an eye-watering $1.9 billion -
after a lengthy U.S. probe showed sweeping problems at the bank.
Lax controls had left HSBC as the "preferred financial
institution" for drug traffickers and money launderers, U.S.
prosecutors said this week.

The concern is that HSBC, Europe's biggest bank, with more
than 60 million customers across 84 countries, is unable to
adequately monitor all its operations, a task made harder by its
history of patchwork acquisitions.

HSBC said it has spent hundreds of millions of dollars to
bolster compliance and simplify its control structure to address
the lapses in anti-money-laundering controls, mainly in its
Mexico and U.S. operations, which led to stinging criticism from
politicians and the record punishment.

"(Chief Executive) Stuart Gulliver is doing a good job
looking after the group, but at the end of the day it is an
absolutely massive bank with branches everywhere; it is
impossible to guarantee that there isn't something going on
somewhere," said Jane Coffey, head of equities at Royal London
Asset Management, an HSBC shareholder.

Gulliver restructured HSBC shortly after taking over at the
start of 2011, setting up global businesses and functions to
improve communication and operations across the group.

In the past, national heads ran all its businesses within
each country, which could result in problems going unnoticed.
The bank needed to improve its internal sharing of information
to help cut down on illicit activity, U.S. Senator Carl Levin
said when he published a scathing report on the bank in July.

In Mexico, where HSBC became one of the top banks with the
2002 purchase of Grupo Financiero Bital, a rapid expansion meant
problems were missed. Between 2007 and 2008, HSBC's Mexican
operations moved $7 billion into the bank's U.S. operations, and
both Mexican and U.S. authorities warned the bank the amount of
money could only have been so high if it was tied to illegal
narcotics proceeds, the U.S. Senate report said.

In early 2008, a Mexican drug lord referred to the bank as
the "place to launder money", U.S. prosecutors said this week.

TALL TASK

Unlike the Libor interest-rate rigging scandal that rocked
UK rival Barclays this summer and forced its chairman
and chief executive to quit, HSBC's fine has not prompted calls
for senior management to step down.

Stephen Green, who was chief executive and then chairman
from June 2003 until December 2010, is now UK Trade Minister and
has faced calls to explain what he knew. He said in July he
shared the "regrets" HSBC had about the failings. Michael
Geoghegan was CEO from May 2006 until the end of 2010, and has
not taken on any major new role.

Critics say the failures highlighted this week show the
scale of the task facing Gulliver; he has simultaneously to
improve returns for investors, meet tougher global regulations,
cut costs and stay on top of potential problems.

For some, it is evidence that banks should be prevented from
becoming too big, especially as HSBC didn't live up to earlier
promises to change.

Back in 2003 New York regulators cracked the whip on HSBC
Bank USA, ordering it to do a better job of policing itself for
suspicious money flows.

The bank promptly hired a tough federal prosecutor to
oversee anti-money-laundering efforts and installed monitoring
systems for operations that had grown unwieldy during its big
U.S. expansion. But in confidential documents that originate
from investigations of HSBC's U.S. operations by two U.S.
attorneys' offices there are allegations that from 2005 HSBC was
not adequately reviewing hundreds of billions in transactions.

When the Senate issued its 400-plus-page report about how
HSBC's lax controls had left it as a financier to clients in
areas tied to drug cartels, terrorist funding and tax cheats, it
accused the bank of having a "pervasively polluted" culture for
a long time.

Gulliver said in a statement after Tuesday's fine: "The HSBC
of today is a fundamentally different organisation from the one
that made those mistakes."

Cormac Leech, banks analyst for Liberum Capital, said he
thought HSBC had done enough to assure investors that it had
dealt with its regulatory issues, pointing to its commitments to
spend more on processes and better monitoring initiatives.

Compliance costs in North America increased by about $200
million in the first nine months of this year, and a review of
customer files will cost about $700 million in the next five
years. Gulliver has recruited senior former U.S. compliance
experts to lead its efforts.

His attempts to streamline the bank and improve compliance
is part of a wider three-year turnaround effort that has seen
him sell dozens of businesses and target $3.5 billion in annual
cost cuts. He is coming to the end of the second year.

"More could be done (to speed up change), but I think a lot
has been done. HSBC was probably more at the incompetent rather
than immoral end of the spectrum," said one of the bank's
biggest 25 investors, who asked not to be named.

"It's like changing the civil service, changing HSBC. It's
such a large organisation. I think there will be large parts of
the group which are quite resistant," he said.

HSBC remains, however, a strong favourite with analysts. Of
33 covering the stock, 22 rate it a "buy", eight have a "hold"
rating and just three consider it a "sell", according to Reuters
data.

"I think a private client can be reasonably confident that
the HSBC dividend is sustainable, that they have good management
in place and that the bank is not unduly exposed to high-risk
areas," said Algernon Percy, head of private clients and manager
of the JO Hambro Investment Management Portfolio Fund and an
HSBC shareholder.